REIT Stocks Jump as Investors Bet on Recovery

Despite poor commercial real estate fundamentals, retail and apartment real estate investment trusts (REITs) are enjoying a powerful resurgence. For the 12-month period ending February 28, a key equity REIT index soared 95.19%, outdoing both the Nasdaq and Standard & Poor’s 500 index of stocks, according to a new report.

For the month of February, U.S. REITs gained more than 5%, according to the report by the National Association of Real Estate Investment Trusts (NAREIT), a trade group based in Washington, D.C. The gains were driven by investment in the retail and apartment sectors, according to the report.

“This has been a period of tremendous growth for REIT shares,” says Ron Kuykendall, vice president at NAREIT. “What it means, I believe, is that investors are betting on a recovery.”

The performance represents a remarkable contrast to the period from the market peak in early 2007 to the trough in March 2009, the lowest point for REITs. Share prices fell a devastating 75% during that period, says Kuykendall.

If investors indeed are betting on recovery, that could provide a shot in the arm to the commercial real estate industry across the U.S. Although REITs comprise just 10% to 15% of the total U.S. commercial real estate marketplace, they represent many of the largest companies and property owners across all property types — retail, multifamily, office, industrial and hotel.

Dealmakers get busy

A developing trend that factors into the recent investment in shares is that acquisitions are once again beginning to take place after the nation’s deep recession and credit shortage, particularly in the retail and apartment sectors.

“We have seen apartment companies like Avalon Bay and Equity Residential doing some strategic acquisitions. It has also begun to happen in the retail sector, where you have of course the General Growth situation,” says Kuykendall. Several rival REITs have expressed interest in buying mall REIT General Growth as it attempts to emerge from Chapter 11 bankruptcy.

“Equity One has been talking to Liberty about acquiring some of their retail shopping centers,” as well, says Kuykendall.

Over the past year, many REITs strengthened their balance sheets as they recapitalized, raising fresh equity through secondary equity offerings and paying down debt, says Kuykendall. The steps made them more attractive to investors.

“There were about $22 billion in secondary equity offerings in the REIT marketplace last year,” says Kuykendall. “That represented more shares coming onto the market.” The offerings followed a trend developing over the past year of share growth rather than a reduction in the number of shares outstanding.

Regional malls recorded an 11.9% return on the FTSE NAREIT Equity REIT Index in February, while shopping centers registered 8.9%. During the month, apartments also showed strong gains of 8.4%, a dramatic improvement from a year earlier. In February 2009, shopping center index returns declined 25.8% while regional mall returns dropped 21.1%. In the same period, apartment returns declined 24.7%.

This year, REITs are generating more optimism. “Investors have been looking forward to the returns that REITs are going to be able to generate by acquiring high-quality property at good prices,” says NAREIT economist Brad Case. “What we’ve seen in the last month is that those opportunities have arrived.”

The investors are driving the prices of REIT stocks up in anticipation of better REIT performance going forward, says Case. He notes that in addition to the improved returns for retail and apartments, lodging REITs recorded a 6% gain in February.

Tough year for fundamentals

The gains have taken place against the backdrop of a brutal climate for commercial real estate fundamentals. The vacancy rate for community and neighborhood shopping centers is projected to rise to 11.5% this year, according to New York-based data research firm Reis. That would represent the highest vacancy rate for the centers since at least 1999.

The shopping center vacancy rate is projected to rise to 12.2% next year. For apartments, Reis projects a vacancy rate of 8.3% in 2010, shattering records for the last 11 years.

Because REITs have been able to raise fresh capital through equity offerings, unlike private companies, they have not been hamstrung by banks’ unwillingness to lend money for acquisitions, says Kuykendall. That has made a crucial difference in their ability to grow as the nation attempts to shake off the effects of the economic slowdown.

Another problem for private commercial real estate companies is that many are weighed down by maturing debts, while banks practice a policy of “extend and pretend” rather than foreclosing on assets.

That’s why the investment marketplace has looked more favorably on REITs, says Kuykendall. Debt maturities still hang over the private companies, while REITs are positioned for opportunistic buys. “These are going to be the winners as banks come to a point where they are no longer willing or able to do the pretend and extend.”